About the author:
Hamid L. Sharif, International Development Expert, Former Inaugural Managing Director of the Complaints-resolution, Evaluation and Integrity Unit at the Asian Infrastructure Investment Bank
The dollar’s dominance, despite the move away from the gold standard, has persisted since the Bretton Woods Agreement in 1944. It continues to command the lion’s share of global trade, at around 84%1 of transactions, while the US share of international trade is much less. As a store of value, it also dominates with 58.36% of all central bank reserves held in dollars.2 Economists who study reserve currencies tell us that one key ingredient for the making of an international reserve currency is the requirement for strict rule of law. Enforceability of contracts, checks on arbitrary use of power, and democratic accountability through the electorate supposedly provide global confidence that the government of the issuing country will behave responsibly, not abuse its power to artificially manipulate the value of the currency (the big fear being devaluation through fiat or inflationary policies) or confiscate assets held in its currency. However, the regulatory failures leading to the Global Financial Crisis, “the U.S. first” approach to economic policy and monetary choices by the Federal Reserve, and more significantly, the increasing use of unilateral sanctions by the U.S. - in what a former official of the US Treasury Department’s Office of Foreign Assets Control (OFAC) describes as its “hidden war”3 - have shaken the confidence of countries around the world in the durability of the US dollar. Thus, for most countries, the search for alternatives to the dollar is a natural and understandable demand. Indeed, when the chips are down and alternatives are available, even countries allied with the U.S. will support the success of substitutes. As such, the shift to a multicurrency world portends greater economic stability and fairer competition.
The control paradox: “My currency, your problem”
The unilateral freezing and confiscation of approximately half of Russia’s dollar reserves following its invasion of Ukraine, and Afghanistan central bank funds held in dollars after the Taliban take-over, illuminated the sovereign and systemic risks rising within the international monetary system by the domination of a single reserve currency. The formerly unthinkable risk of reserve currency weaponization, to coerce other countries to follow US foreign policy objectives, or more charitably, its own interpretation of international law, has been realized.
The application of American laws beyond its physical borders has been a matter of controversy and consternation for nations around the world. However, the use of such extraterritorial application, predicated on the status of the dollar, impinges on the freedom of other nations to pursue their national interest through foreign policy choices. Simply put, legal extraterritoriality undermines the very notion of sovereignty. As the Afghan case starkly demonstrates, it also effectively punishes ordinary citizens when a state cannot access its reserves for legitimate trade, development, or meet the basic needs of its people such as essential food and fuel.
Weaponization of sanctions deliberately undermines the polity of nations targeted. Indeed, US officials have made no secret of their aim to seek regime change in Iran, Russia, or Afghanistan by fomenting disaffection through hardships among the people; confiscating dollar reserves and shunning them from international trade. The sanctions cover all dollar-based dealings with these countries and even non-dollar trades or transactions that assist these countries in certain areas (e.g., any investment or dealings related to technologies in the petroleum sector) by punishing third-party sovereign and non-sovereign entities deemed to be involved.
Such unilateral sanctions, originally developed and refined to counter drug smugglers or terrorists, were initially supported by the international community. However, the increasing ferocity of these measures has reached fever pitch in recent years even extending to other traditional great powers. The fact that under US law these are executive decisions to prevent harm means they do away with the legal safeguards that are required in criminal or civil proceedings. As administrative proceedings, they simply require reasonable evidence (as assessed by the decision maker) to freeze accounts or put offending persons or entities on the designated sanctions lists. Indeed, no prior notice or hearing is necessary as the notice requirement simply alerts the alleged offenders to make alternative arrangements. To the extent of alleged criminality, and as part of the global consensus to fight drugs and terrorism, nations have accepted these measures. However, the use of the same logic in respect of sovereign central bank reserves, and that to bring about changes in the targeted nations’ foreign policy or regime change, is untenable and wreaks collateral damage on unintended parties. In this context, summary extraterritoriality is not only an affront to the very notion of sovereignty, but the legality of such actions under international law is highly dubious.
Contested legality of unilateral sanctions
The usual defense of such actions is to resort to the UN Charter, which allows nations to use peaceful means to settle disputes. As international law relies on states to enforce it, the argument made is that a state can use “retorsions or countermeasures” to enforce compliance with international law. It is beyond this short article to thoroughly discuss the legality of unilateral sanctions of the type introduced by the U.S. What is worth noting, however, is that their legitimacy is contested. When do unilateral sanctions constitute “retorsions or countermeasures” that are in conformity with international law? The Draft Articles on Responsibility of States for Internationally Wrongful Acts (2001) prepared by the International Law Commission (ILC) reflect international customary law on the subject. In terms of the principles articulated by the ILC, it is contestable whether unilateral sanctions by a single state, that is not considered an “injured state,” are lawful. In the absence of clear jurisprudence on the subject, the net effect is that a powerful state, such as the U.S., is the prosecutor, judge and executioner for the purposes of deciding what constitutes violation of international law and what countermeasures can be taken to force the offending state, and other states, to conform.
Unilateral American sanctions also undermine human rights guaranteed under international law. Indeed, this has led to the appointment of a Special Rapporteur on the negative impact of the unilateral coercive measures on the enjoyment of human rights. In March 2023, the Special Rapporteur, Ms. Alena Douhan, stated that “The United States has for years been imposing sanctions on individuals and entities without national criminal jurisdiction and in the absence of universal jurisdiction. This is clearly a violation of due process rights, including the presumption of innocence and fair trial.” The latter rights are guaranteed under the International Covenant on Civil and Political Rights. The Special Rapporteur further stated that, to the extent that the US sanctions prohibit entry to the U.S. and freeze any assets with a US connection, are violative of the rights of movement and are not to be arbitrarily deployed for the deprivation of property.4
The primacy of the dollar as the reserve currency of the international monetary system allows the U.S. to weaponize both its access and use. This presents a major dilemma for all nations.
The freezing and seizing of assets: actualizing expropriation
US sanctions have been used to freeze the assets of targeted states including their dollar reserves. Even temporary freezing can severely interfere with a state’s ability to meet its obligations, and is, therefore, tantamount to seizure of the asset. There is now open discussion in the U.S. to move beyond freezing of assets. In the increasingly polarized polity of the U.S., where each party is set to outdo the other on proposing extreme measures against the enemy du jour, there is serious academic discussion about whether the American President can order seizure once assets are frozen. While there is strong academic opinion suggesting current laws (mainly the International Emergency Economic Powers Act of 1977) do not allow for such seizure, there is significant academic opinion arguing the contrary.5 Disconcertingly, debate centers around permissibility of such seizure under current US laws rather than on the desirability of such a power and its exercise. Can the world’s central banks ignore the possibility of a US president exercising such powers? Ordinarily, this would be inconceivable. However, in the high-stakes political gambit of US electoral politics, the possibility cannot be ruled out.
Whither Europe?
While both the European countries and the U.S. concur on Russian sanctions, it is important to bear in mind the European reaction to President Trump’s unilateral repudiation of the Joint Comprehensive Plan of Action (JCPOA), or the Iran nuclear deal signed by Iran, the Permanent Members of the UN Security Council (China, France, Russia, the United Kingdom, and the U.S.), and the European Union. The effect of US unilateral sanctions was to scupper European investments amounting to hundreds of billions of euros. The threat of locking out European banks and companies from the US financial system was simply untenable. Committed to abiding by the JCPOA, the Europeans could not proceed without risking extreme consequences for their banks and companies. As such, then German foreign minister Heiko Maas called for the creation of a new payments system independent of the United States. In an article published in the Handlesblatt, Maas wrote that Europe should not allow the U.S. to act “over our heads and at our expense,” adding that “for that reason it is essential to strengthen European autonomy by establishing payment channels that are independent of the U.S., creating a European Monetary Fund and building an independent SWIFT [Society for Worldwide Interbank Financial Telecommunication] system.”
European weariness of dollar dominance was not concealed during President Macron’s visit to China in early 2023. During his visit, French companies reportedly signed deals allowing payment in RMB, and further reports have shown that payment in RMB was made under one such contract.
Asia's search for a financial safety net
The 1997 Asian financial crisis underscored Asia’s need for a financial safety net. To this end, Japan floated the idea of creating the Asian Monetary Fund. The U.S., consistent with its efforts to thwart any regional organizational arrangements that excluded it, pushed back and Japan balked. However, the creation of a financial safety net continued under the ASEAN+3 (Japan, South Korea, China). This led to the Chiang Mai Initiative, a network of swap arrangements that were converted into the Chiang Mai Initiative Multilateralization (CMIM), which is a single agreement for currency swaps. CMIM was complemented by other initiatives such as the Asian Bond Markets Initiative (an arrangement to promote local currency bonds) and the ASEAN+3 Macroeconomic Research Office (AMRO), which was created in 2011 for macroeconomic surveillance. The ASEAN+3 carefully aligned themselves to the IMF, so that under the CMIM only 30% of the agreed amount for any country can be disbursed without an IMF program. It was hoped that these arrangements would pave the way for an Asian Monetary Fund, allowing Asian countries to tailor solutions to future financial crises. However, regional and global geopolitical shifts have retarded realization of the AMF. The rivalry between Asian countries has intensified due to the US declaration of China as a strategic threat and competitor; a refrain transformed to a chorus and sung by the G7 at their latest meeting in Hiroshima.
Territorial disputes between China, Japan, and India are particularly noteworthy as they have led to fast-changing security arrangements including revival of the quadrilateral alliance (the Quad; Australia, India, Japan, U.S.) and AUKUS military alliance (Australia, UK, U.S.). The emergence of these security alliances and Japan’s participation in the U.S.-led “chip war” against China do not bode well for collective financial networks such as the proposed AMF, although the CMIM and AMRO may keep alive the hopes espoused at its genesis.
The 1997 Asian and the 2008 global financial crisis laid bare the risks arising from US economic policies and regulatory failures. Asian countries must, therefore, resort to other measures to manage financial risks arising from the dollar’s dominance. The Iranian sanctions and the more recent sanctions following the Ukraine crisis have underscored a more aggressive use of the power arising from the dollar’s dominance. In this respect, Asian countries share a common concern with other emerging market and developing nations that have accumulated large dollar reserves as a hedge against financial crises, and whose faith in the international monetary system geared towards dollar supremacy is eroded. Unsuspectingly, they may also find lurking allies among the Europeans. On the face of it, Europe may take short-term comfort in their alliance with the U.S. However, President Trump’s repudiation of the JCPOA and subsequent unilateral sanctions levied against Iran still haunt them. It is unlikely that the two main drivers of the European Union, France and Germany, can continue to ignore the European vulnerability to, and dependency on, dollar domination.
Enter the dragon
While the euro has emerged as an international currency, it has suffered a setback since the Global Financial Crisis; even more so considering the unfolding international financial situation that highlights the weakness of the euro vis-à-vis the dollar. The pound sterling is on the decline in a post-Brexit world and the yen has limited potential to grow further as an alternative reserve currency. The serious contender to emerge as a significant alternative is the Chinese RMB. Faced with such situation, China has the economic heft to take on the consequences of a more internationalized currency. Its trading position and increasing domestic demand, predicated on the government’s desire to raise per capita income up to $30,000 by 2035, should enable China to raise imports from the rest of the world. While China remains wary of opening its capital account, its experimentation with alternatives, to allow deeper financial markets, is impressive.
With growth of the off-shore RMB market encouraging a “one currency, two markets”6 model - a network of bilateral swap agreements, the inclusion of the RMB in the SDR basket of currencies by the International Monetary Fund since 2016, the linking of the Shanghai Stock Exchange with the Hong Kong Stock Exchange, and the more recent swap connect - China has created an impressive infrastructure for allowing greater international use of the RMB without opening up its capital account. The roll-out of the digital RMB may further facilitate greater use of RMB globally. The digital RMB also promises to bring down transaction costs as it narrows information asymmetry for users. Since 2015, the RMB’s use in international trade has grown significantly (though China still punches well below its share of international trade) given the Belt and Road Initiative (BRI) and its prominent position in international trade. Calls by President Xi for greater use of the RMB for trading oil promise to further increase the currency’s prominence. Similarly, according to the IMF, by 2022, RMB use by other central banks had also grown, although it constituted less than 5% of the total reserves of central banks together with pound sterling and the yen.
The modest use of the RMB in international trade and as a reserve has led most commentators and researchers to conclude that there is no imminent threat of de-dollarization. This may be the case, however, what cannot be discounted is a global yearning for the international monetary system to adopt a multicurrency system that one state cannot monopolize or dictate the economic policy or relations of other countries. What may seem like calm today may easily cascade into turbulence. This will depend on how China steers the internationalization of the RMB to give confidence to other countries on its management of the economy, especially policies that effect the value of the RMB, as well as on how the U.S. makes decisions on dollar weaponization. America must also consider prudent management of its economy and polarized politics to mitigate the risk. Its instability should not be borne by the rest of the world.
Multicurrency world as a global opportunity
A multicurrency world need not be all negative for the U.S. Being the effective world reserve currency comes at a cost of perpetual current account deficits and financialization of assets at the expense of the real economy. The emergence of other currencies that garner a greater share of world trade and reserve currency can provide the U.S. with the market discipline its real economy needs to generate manufacturing and employment. In the process, a broader burden sharing among several currencies can help the US economy avoid the downside risks that a lop-sided reliance on the dollar creates. A multicurrency international monetary system portends greater stability for the world economy.
1. Jindong Zhang, Winni Zhou and Tom Westbrook, “Yuan overtakes dollar to become most-used currency in China's cross-border transactions,” Reuters, April 26, 2023, https://www.reuters.com/markets/currencies/yuan-overtakes-dollar-become-most-used-currency-chinas-cross-border-transactions-2023-04-26/.
2. International Monetary Fund, “Currency Composition of Foreign Exchange Reserves (Cofer),” March 31, 2023. https://data.imf.org/?sk=E6A5F467-C14B-4AA8-9F6D-5A09EC4E62A4.
3. Juan Zarate, Treasury's War: The Unleashing of a New Era of Financial Warfare (New York City: Public Affairs, 2013).
4. Press Release of UN Office of the High Commissioner for Human Rights, March 9, 2023.
5. Paul B. Stephan, “Seizing Russian Assets.” Capital Markets Law Journal (2022), Vol. 17, https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4129862.
6. Edward L.-C. Lai, One Currency, Two Markets: China's Attempt to Internationalize the Renminbi.(Cambridge: Cambridge University Press, 2021).
Please note: The above contents only represent the views of the author, and do not necessarily represent the views or positions of Taihe Institute.
This article is from the March issue of TI Observer (TIO), which is a monthly publication devoted to bringing China and the rest of the world closer together by facilitating mutual understanding and promoting exchanges of views. If you are interested in knowing more about the October issue, please click here:
http://www.taiheinstitute.org/Content/2023/05-31/1621340940.html
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